War: 2013?

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US-China Relations: War in 2013?

 Posted By Addison Wiggin On January 28, 2013 @ 3:21 pm In Addison Wiggin,Economics,Featured Post,Investment News,Investment Strategies,Markets,Politics,The Daily Reckoning | 6 Comments

War between the US and China — an unpleasant thought, for sure…unless you happen to be a defense contractor. The threat of war could be sufficient to power the defense industry’s profit growth for many years.
We would not be tackling this grim topic — nor engaging in the financial market version of grave-dancing — if the suits and uniforms in Washington understood that China is merely implementing its own version of the Monroe Doctrine.
If you don’t remember the Monroe Doctrine from history class, it goes like this: President James Monroe in 1823 put the European powers on notice that if they meddled anywhere in Latin America, the United States would step in to put a stop to it. It was a big “keep out of our backyard” sign.
OK, it was more subtle than that; an aging Thomas Jefferson congratulated Monroe on achieving a “cordial friendship with England.” The doctrine was, indeed, a tacit agreement between the United States and Great Britain. The US took a free ride on the Royal Navy. Its ships patrolled the waters surrounding Latin America, keeping the continental powers far from America’s doorstep.
The original Monroe Doctrine aimed to keep Europeans away. China’s Monroe Doctrine aims to keep the United States from getting closer than it is already.
“The Pacific basin has long been home to the United States’ largest trading partners, and Washington deploys more than 320,000 military personnel in the region, including 60% of its navy,” writes Conn Hallinan of the think tank Foreign Policy in Focus. “The American flag flies over bases in Japan, the Philippines, South Korea, Malaysia, Thailand, the Marshall Islands, Guam and Wake.” The US Seventh Fleet routinely sails near the Chinese coast, to the edge of the “12-mile limit” where international waters end.
No wonder Chinese leaders sense — rightly or wrongly — that they’re being encircled.
“China has made it clear that it will not tolerate the threat to its security represented by a foreign military presence at its gates when these foreign forces are engaged in activities designed to probe Chinese defenses and choreograph a way to penetrate them,” writes our acquaintance Chas Freeman, the veteran US diplomat who was President Nixon’s interpreter on his groundbreaking visit to “Red” China in 1972.
“There’s no reason to assume that China is any less serious about this than we would be if faced with similarly provocative naval and air operations along our frontiers.”
Thus are the Chinese asserting their dominion over the disputed Senkakus Islands. “China sees the islands as part of its defensive parameter,” Hallinan explains, “an understandable point of view considering the country’s history. China has been the victim of invasion and exploitation by colonial powers, including Japan, dating back to the first Opium War in 1839.”
China also insists it rightly controls a host of islands in the South China Sea — rich fishing grounds and a potential source of oil and gas. These islands, such as the Spratlys and Paracels, are also claimed by… oh, let’s run down the list: Vietnam, Malaysia, Taiwan, Brunei and the Philippines. Maybe the Kardashians too, for all we know.
In addition, China has…

• Commissioned its first aircraft carrier
• Developed a whiz-bang stealth fighter jet called the J-20
• Goosed its defense spending by double-digit percentages every year for the past decade (although Beijing’s defense budget it still one-fifth the size of Washington’s).

A sensible US response would go something like this: “Hey, China’s implementing its own Monroe Doctrine. They want to be in charge in their own backyard. Meanwhile, we’re $16.4 trillion in debt. Heck, we owe $1.1 trillion of that to China. Why are we going deeper in debt to keep 60% of the Navy stationed in the Pacific basin? Maybe we should reconsider this whole ‘American lake’ thing.”
Instead, the US government is doubling down.
“As the war in Iraq winds down and America begins to withdraw its forces from Afghanistan, the United States stands at a pivot point,” Secretary of State Hillary Clinton wrote in Foreign Policy’s November 2011 issue. “One of the most important tasks of American statecraft over the next decade will therefore be to lock in a substantially increased investment — diplomatic, economic, strategic and otherwise — in the Asia-Pacific region.”
In DC wonk circles, this statement of intentions has come to be known as “the pivot.”
The same month Clinton published that article — with the presumptuous title “America’s Pacific Century” — the Obama administration stationed 2,500 US troops on Australia’s northern coast for the first time. More encirclement.
This “pivot” opens up an intriguing investment angle. Think of it as channeling some of your tax dollars back into your own pocket. The US defense industry is positively salivating over the pivot.
As 2012 wound down, the Aerospace Industries Association — whose membership roster reads like a list of ITA’s top holdings — issued its annual industry forecast. Reuters summed it up like this: “US sales of warplanes, anti-missile systems and other costly weapons to China’s and North Korea’s neighbors appear set for significant growth amid regional security jitters.”
Not to put too fine a point on it, the pivot “will result in growing opportunities for our industry to help equip our friends,” enthused AIA vice president Fred Downey. Orders from Asia will more than make up for a slowdown in buying by those parsimonious and peacenik Europeans.
And even if the automatic cuts in the US take effect, “contractors such as Lockheed, Boeing, Northrop and Raytheon Co. expect regional demand for their products and services to help them offset Pentagon belt-tightening,” says Reuters.
The AIA didn’t put numbers on its forecast, but pressed by Reuters, the industry group disclosed that sales agreements with countries under the US Pacific Command’s umbrella grew 5.4% in fiscal 2012 — to $13.7 billion.
Nevertheless, J.P. Morgan recently downgraded several of the big defense-sector names: “We believe,” said its report, “that Republicans as a group put a higher priority on spending cuts than they do on preserving the defense budget.”
We have our doubts… but even if that turns out to be true, there’s still money to be made from the pivot. Back in November, we urged the subscribers of Addison Wiggin’s Apogee Advisory to buy shares of The iShares Dow Jones US Aerospace and Defense ETF (ITA). The stock is up about 15% since then. But as the pivot proceeds, we would expect this stock to continue trending higher.
Regards,
Addison Wiggin ^[4]
for The Daily Reckoning ^[5]